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(May 2008) If you are disabled, an inheritance can hurt you or help you. It depends on how things are structured.

The story of Leonard and Audrey Henson

Leonard Henson had a daughter named Audrey. She was mentally disabled. The Ontario government provided her with a monthly cheque as income support. It also provided her with government programming that was critically important to preserving her lifestyle. All appeared to be well. Leonard could visit her, and used his own money wherever necessary to make sure she had the little extras that made her happy and comfortable. But trouble was brewing.

Leonard was getting older. He wanted to leave an inheritance to Audrey, but knew that the government of Ontario was going to cut off her income support and some of her programming if she inherited any wealth from him. The income support and programming was only available to recipients who were financially eligible. Audrey would not be eligible if she had a few hundred thousand dollars in the bank.

Leonard Henson and his lawyers drafted a specialized last will and testament. It established a trust to hold Audrey's inheritance. Her money would be held on her behalf by trustees appointed under the will. They would spend the money for her benefit, buying her the extras that her father always had, but Audrey would never legally be able to demand any of the money. The decision to give her money from the trust was exclusively at the discretion of the trustees who would only give her money if it improved her lifestyle. They would not give her money if there were any chance it would disqualify her from government support.

When the will was well drafted, Leonard must have loved it. When he died, though, the government of Ontario was less impressed. They cut Audrey off, discontinuing her income support. Effectively, they told the trustees to support her out of the trust until the whole of the inheritance was gone, at which time she would then be eligible to reapply for income support.

The trustees decided to fight the government. The case wound its way through administrative tribunals and courts all the way up to the Ontario Court of Appeal. The trustees won: The court said a disabled person like Audrey could inherit under a fully discretionary trust and still remain eligible for government support and programming.

The wheels of justice grind slowly though, and the legal dispute lasted for years. Audrey died before the final ruling.

A fully discretionary trust for a disabled person has come to be called a "Henson trust." These trusts are now a mainstay in estate planning for disabled heirs across Canada. The exception is Alberta, where the rules were changed in 1999 to make these trusts ineffective.

In the past 20 years that Henson trusts have been on the legal landscape, we have learned some lawyers do a good job drafting a Henson trust and others don't. A financial advisor can help a client by recommending the use of a Henson trust, but also by knowing enough to make sure the client is getting exactly what the family needs.

A passing grade

At the core of a Henson trust is the language which makes it clear that the income and capital in the trust is to be parcelled out for the benefit of the disabled heir, only when the trustees decide to do it.

If you find any language in the trust that discusses mandatory payments or would allow the beneficiary to demand any payment or distribution from the trust, then it fails as a Henson trust.

Consider a clause, for example, that provides that "the trustees shall pay a monthly allowance to my disabled child equal to half of the income earned by the trust in each year." That language would put the trust offside. Why? If the trustees withheld payment of the allowance, payment could be forced by a court.

Next: The published decision quoted language from Leonard Henson's will at some length. Any lawyer drafting a Henson trust would be well advised to simply cut and paste the same language into the will he or she is drafting.


 

The published decision of the Ontario court in Henson quoted the language from Leonard Henson's will at some length. Any lawyer drafting a Henson trust would be well advised to simply cut and paste the same language into the will he or she is drafting. Look for this language or language much like it:

No Vested Interest — No interest in the capital of the trust or in the income thereon, or any portion of either, shall vest in [beneficiary name]. His interest shall be limited to any sums paid to him or paid on his behalf.

Going from a passing grade to an "A"

These are the basics, but after 20 years of drafting Henson trusts, many lawyers are now going beyond just the basics.

A well-drafted Henson trust is built to stand the test of time, since it might be in place for several decades. Trustees selected by the client may not survive the disabled heir. Thus, the trust should allow for replacement trustees to be appointed when initial trustees are getting long in the tooth.

A well-drafted Henson trust should be flexible. The trust might contain clauses allowing the trustees to wind up the trust if it no longer serves its purpose. At windup, the trustees might have the option to purchase an annuity for the disabled heir, or even to give the money to them directly where that makes sense. The trustees might like a provision expressly allowing them the chance to appoint a trust company and resign.

A well-drafted Henson trust will contain language making it clear that the trustees can spend money freely on the disabled beneficiary, without any regard for how much money might remain in the pot for the subsequent generation of beneficiaries after his or her death. Otherwise, an "even-hand rule" may operate to force a legal balancing act between the disabled heir and future beneficiaries.

A Henson trust "with distinction"

Changes to the Income Tax Act have been announced that will allow for the tax-free rollover of registered investments into a trust for a disabled family member. This allows for the deferral of taxes that would otherwise be triggered at death. To qualify, the trust will have to meet requirements of the soon-to-be enacted section 60.011 of the Act, which describes a trust where income and capital are to be used for the "comfort, care and maintenance" of the disabled beneficiary. If that rollover is to be secured, the trust should contain clauses using the same language to create a close link between the trust and the language permitting the rollover.

At the technical forefront, some Henson trusts are drafted to sidestep the difficulties that arise in Ontario because of the "rule against accumulations." This trust rule, not a tax rule, provides that income earned by a trust in Ontario can be kept in the trust for the first 21 years only. In the 22nd year of the trust's existence, all income earned on trust assets must be paid out each year.

If the income is paid out to satisfy this accumulation rule and the beneficiary of the trust is disabled, the mandatory payment of income to them would make them ineligible for government support. Thus, draftspeople in Ontario usually include a clause to include a pool of income beneficiaries, one of whom is the disabled heir, and provide that the mandatory income stream be directed among the pool on a discretionary basis.

That solves the accumulation problem, but can be an unpalatable solution for other reasons. The client usually wants the money to benefit the disabled family member — an income clause spreading the income among others is generally contrary to the client's wishes. The client may want the trust to grow. Growing the trust becomes difficult when all of the income needs to be distributed. Reinvesting it allows for faster growth.

Is there a better solution? The trust can be structured in a way to be governed by the laws of a province other than Ontario. To achieve that, the trust is best set up while the parent is alive, should not contain land and should be administered by trustees resident in the other province. It should also contain a clause expressly choosing the accumulations law of the other province as intended to govern the trust.

A basic Henson trust is a necessity for most families with a disabled beneficiary. The better the Henson trust, the better the outcome for the disabled heir.

John Poyser is a lawyer with the wealth and succession practice group at the Winnipeg firm Inkster, Christie, Hughes LLP, and co-authors a textbook on trust and estate taxation. jpoyser@inksterchristie.ca

(05/06/08)

Originally published on Advisor.ca